Middle-Class Mortgage Break Tough to Curb in Debt Talks

By Richard Rubin and Dan Levy -
Apr 5, 2013

U.S. lawmakers are looking for ways
to carve up the $70 billion-a-year home mortgage interest
deduction.

What they’re finding is a political challenge that might
not yield much revenue for reducing the budget deficit or
lowering tax rates and may not be worth the outcry from
taxpayers making between $75,000 and $200,000 a year.

A variety of ideas are being discussed to curtail the break
without ending it. Options include lowering the $1 million cap
on the size of deductible loans, eliminating the benefit for
second homes and imposing limits on top earners’ itemized
deductions, including mortgage interest.

Still, any plan that generates significant revenue would
pinch the housing industry and upper-middle-class voters. Real
estate agents and homebuilders are in every congressional
district, and more than half the benefits of the tax break go to
households earning between $75,000 and $200,000, the homeowners
both parties are pledging to protect.

“It’s so woven into our economy that it’s hard to do
without having economic dislocation that produces more pain than
the revenue gained,” said former Representative Earl Pomeroy, a
North Dakota Democrat.

In 2011, 36 million households claimed $359 billion in
mortgage interest deductions, according to theInternal Revenue
Service. That was down from 37 million and $387 billion the year
before.

Detailed Discussions

The most detailed discussions about the deduction are
happening in the House of Representatives, where the tax-writing
Ways and Means Committee has broken into 11 bipartisan working
groups to study ways to rewrite the U.S. tax code. The groups
are wrapping up their work by April 15.

The committee plans to release and pass a bill this year.
Republicans emphasize their willingness to consider anything
while not yet proposing anything specific.

“I don’t think the committee knows where tax reform is
headed, or how broad it will be,” Jamie Gregory, a lobbyist for
the National Association of Realtors who has been invited to
working group meetings, said in a phone interview. “It’s a
difficult issue with a lot of moving pieces.”

Second-Home Deduction

Narrower options, such as ending the deduction for second
homes, could raise about $8 billion a year. Converting the
deduction into a 15 percent credit and capping indebtedness at
$500,000 would yield $24 billion a year by 2019 and cause about
half of households earning between $100,000 and $200,000 to pay
more tax, according to the nonpartisan Tax Policy Center.

Changes limited to the top 2 percent of earners or
reductions to the $1 million cap would have the biggest effect
in high-cost real estate markets, such as those in California,
New York and New Jersey.

Four of the 10 most expensive U.S. housing markets last
year were in California, led by the San Jose metropolitan area,
according to the National Association of Realtors.

What’s important is how the deduction fits in a tax plan
designed to lower rates and promote U.S. economic growth, said
Representative Diane Black, a Tennessee Republican on Ways and
Means who said the second-home deduction is under scrutiny.

“The best thing for folks to get to be able to afford a
house is a job and higher wages,” she said.

1986 Survivor

The mortgage interest deduction is a long-standing feature
of the tax code and a survivor of the 1986 rewrite that
prohibited taxpayers from deducting credit-card interest.

It’s available only to the one-third of U.S. taxpayers who
itemize their deductions, and that means it disproportionately
benefits higher-income earners with higher marginal tax rates.

The tax break’s defenders warn that scaling it back could
discourage homeownership, causing home prices to drop with
ripple effects in the construction, furniture and appliance
industries whose fortunes rise and fall with the housing market.

David Stevens, president and chief executive officer of the
Mortgage Bankers Association in Washington, said his group would
consider changes to the deduction as part of a broad-based
deficit-cutting plan as long as policy makers carefully analyze
the potential effects.

Values Rebound

Last year, median home values across the country continued
to rebound, rising 6.4 percent to $176,900, according to the
National Association of Realtors. The nation’s most expensive
markets included the metropolitan areas of San Jose, San
Francisco, San Diego, Los Angeles, New York, Boston, Washington,
Seattle and Denver, the Realtors group said.

Limiting the mortgage deduction “is a lot more likely now
than before” the financial crisis, especially with lawmakers’
focus on deficit reduction, said Greg Reiter, head of
residential mortgage research at Wells Fargo & Co. (WFC), the biggest
U.S. home lender with about one in three residential mortgage
originations.

“It would effectively raise a borrower’s monthly payment
and lower house prices,” Reiter said in a phone interview. “It
would be smart to do it gradually, so we don’t kill the whole
thing.”

Reducing the $1 million cap would have relatively little
effect on taxpayers because loans that large are rare, said
Stevens, former commissioner of the Federal Housing
Administration. Many homeowners in that category have other
assets they could use to pay off the portion of their mortgage
that would exceed a lower cap.

‘Emotional Win’

“That becomes more of an emotional win for those that want
to take it out of the wealthy, per se,” he said. “You’re not
going to get a significant pick-up in tax revenues as a
result.”

Reducing the cap to $500,000 would affect fewer than 10
percent of mortgages, some of which include vacation home debt
in a single mortgage, said Todd Sinai, associate professor of
real estate and business economics and public policy at the
University of Pennsylvania’s Wharton School.

“The reason to lower the mortgage cap from $1 million to
$500,000 is really to not index it for inflation and have it be
more binding in the future,” he said.